In an interview with Sougata Ray, Professor of Strategy, Indian Institute of Management Calcutta, and Visiting Advisor, Thomas Schmidheiny Centre for Family Enterprise, ISB, Adi Godrej, Chairman, the Godrej Group, shares his thoughts on corporate governance in family businesses.
The 120 years old Godrej Group has emerged as an icon among family businesses in India, not only for its economic achievements but also for its relentless focus on achieving excellence in corporate governance. Adi Godrej joined the family business in 1963 after earning Bachelor’s and Master’s degrees from the Sloan School of Management at MIT. He became the chairman of the conglomerate in the year 2000. Under his leadership, the Godrej group has become one of the fastest growing business groups in the country with US$ 4.1 billion in revenues as of now.
Mr. Godrej also served as the chairman on the Committee of Corporate Governance constituted by the Government of India in 2012 and has been playing a stewardship role in improving the corporate governance practices in India. He has received numerous awards during his long tenure at the helm of the Godrej group, including the Golden Peacock Lifetime Achievement Award for Ethical Leadership 2016 instituted by the Institute of Directors (IOD), India. In an interview with Sougata Ray, Professor of Strategy, Indian Institute of Management Calcutta, and Visiting Scholar, Thomas Schmidheiny Centre for Family Enterprise, ISB, Mr. Godrej shares his thoughts on corporate governance in family businesses.
Sougata Ray: What does governance mean for a family enterprise?
In my opinion, corporate governance should be defined as effi cient supervision which encourages ‘doing everything better’, and protects the interest of the Company while conforming to all established laws and ethics.
Very often, especially in the wake of the recent discoveries of corporate malfeasance, corporate governance tends to be confused as ‘the protection of the interests of minority shareholders’. This misconstrued notion couldn’t be farther from the truth. Corporate governance should promote the long-term good of the company and not necessarily of a particular group of stakeholders. It is well understood that neglecting or bypassing the interests of stakeholders like shareholders, employees, vendors, customers, consumers, the government, or the society at large is likely to adversely affect the long-term interests of the company.
You said, “Corporate governance should promote the long-term good of the company and not necessarily particular stakeholders”. Could you please explain this further?
Sometimes SEBI (Securities Exchange Board of India) and government bodies try to put too much emphasis on protecting minority shareholders’ interest. I am not saying that the minority interest should not be protected. But the most important principle of governance, the most important objective of a board should be the interest of the company. A good management should be looking into the interests of all stakeholders. But the ultimate interest that should be protected is the company’s. All these other things come as part of the company’s interests and not as primary interest.
Very often, especially in the wake of the recent discoveries of corporate malfeasance, corporate governance tends to be confused as ‘the protection of the interests of minority shareholders’.
This makes perfect sense. Yet, why do you think there is so much emphasis on protection of minority shareholders’ interest in the context of family enterprises?
I think we get confused because we automatically assume that people will sacrifice minority shareholder’s interest in promoter interest and, therefore, we should go out of our way to protect it. I think we should go out of our way to promote corporate governance, to protect the company’s interests and ensure that the company’s interests include the interests of various stakeholders.
Does the short-term focus in terms of quarterly performance or annual performance affect corporate governance in some ways or the other?
A good board will not over-emphasize the quarterly results at the cost of the company’s long-term interests. The company’s long-term interest is what is important. One advantage family businesses have is that they don’t need to chase quarterly numbers. They may have to report quarterly results but nobody is going to complain if the quarterly results are not good so long their policy is good for the long term.
Godrej Group is known to put heavy emphasis on constantly improving corporate governance under your stewardship. You have also been very active at the highest level of policy making for improving the general standard of corporate governance in Indian companies. What is your general advice to leaders of family enterprises to improve corporate governance?
I believe it is important that corporate governance be principle-based rather than rule-based. This is essential since principles are harder to ‘get around’ compared to rules. In trying times the temptation to seek loopholes in the rules remains large. However, with principle-based corporate governance, the quality of governance is as robust as the principles.
Corporate governance principles need to be simple, to be easily and widely understood. In the ideal scenario, every employee – from the chairman to the shop-floor worker – becomes a custodian of the company’s interests. Simple principles are both easy to implement and enforce. Further, simple and moral principles are important to ensure that governance is an aid and not a barrier to market development.
Corporate governance principles need to be simple, to be easily and widely understood. In the ideal scenario, every employee – from the chairman to the shop-fl oor worker – becomes a custodian of the company’s interests.
Good governance means high levels of accountability and responsiveness. The need of the hour is not more rules, laws, and bye-laws but effective enforcement. Our government and market regulators need to enforce the existing legislation rather than create more legislation. Legislation alone is no panacea and unenforced legislation is worse than no legislation.
You seem to be emphasizing on the spirit of corporate governance more than the letter. On another occasion you had made a statement – “Lacuna in Indian corporate governance will be not what is missing in the letter of the law but what is missing in the internalization and the implementation of it”. Would you like to elaborate, please?
What I meant is that there are issues of corporate governance and then there are issues such as social issues, political issues, in the country. Government’s efforts to solve all the issues only through legislation is not the way to do it. It is important to encourage people and train them to follow the right path – corporate governance is one of them. Instead of making more and more laws and then people trying to find loopholes in the laws, it is much better to train people, explain to them why it is good to follow good corporate governance. Just having more laws don’t necessarily solve all problems. Good methods are also very important.
Are there special issues related to corporate governance in family enterprises as compared to firms promoted by other forms of ownership?
There are certain unique characteristics of the family managed businesses that necessitate good corporate governance principles as an essential element, to ensure their successful survival.
First, family firms have to endure all the complexities of family interaction, in addition to the features of the business. This additional level of complexity exerts itself most significantly at the time of a generational change. In the 2016 survey conducted by PricewaterhouseCoopers on 2800 mid and small-sized family businesses from 50 countries revealed that 43% of family firms did not have a discussed and documented succession plan in place.
The second risk associated with family managed businesses flows from my previous point about succession. A number of studies indicate that only 5% of all family managed businesses continue to create shareholder value beyond the third generation. The generations following the founder may not be as united or as driven as the founder. They may lack interest or simply lack the skills necessary to run the business and take it to the next level of growth. The question that, therefore, presents itself is: What differentiates this 5% from the rest of the pack? The answer, in my opinion, is simply a good corporate governance system which identifies business participants, develops management talent and demarcates roles and responsibilities, of these participants, linked to their talents and capabilities.
The third risk associated with family managed businesses is one of perception. A family managed businesses, save for a few exceptions, have historically been seen as unprofessional and, therefore, been unable to attract and retain the requisite non-family management talent to drive these businesses to create value. This reluctance is largely due to the fact that these businesses are seen to operate on the whims of the owners or promoters. The lack of formal talent development plans, performance management systems and the absence of transparency in promotions and remuneration deter potential talent from entering and participating in the management of these companies.
Are you then saying that sound principles, mechanisms, and practices associated with good corporate governance are very important for the sustainability of family enterprises?
Absolutely! Sound corporate governance addresses these risks inherent in the characteristics of the family managed businesses systematically and sustainably.
The benefits of having top-notch corporate governance are plenty: 1) Good governance provides a competitive advantage in the global marketplace. 2) Well-governed companies raise capital widely, easily, and cheaply. 3) Good governance leads to improved employee morale and higher productivity. 4) Well-governed companies last longer. Also, an increasing amount of evidence does suggest that there is a strong link between corporate governance and financial performance. It is also important to remember that ‘the market’ is the definitive compliance officer. The increasing power of the capital market to discipline errant management and/or the dominant shareholder, by denying him or her access to the capital market, is a strong reason to take corporate governance seriously. The newly unleashed forces of deregulation, disintermediation, institutionalization, globalization, and tax reforms are making the minority shareholder more powerful, and are forcing the companies to adopt healthier governance practices. How does one ensure sound corporate governance in a family owned enterprise? Good corporate governance must include the framework of a strong performance orientation. Conformation to good governance is a hygiene factor – performance is important. Good governance needs to incorporate leadership and management imperatives that can lead to strong financial and strategic performance. Corporate governance and performance are not mutually exclusive – on the contrary, companies with sustained sterling performance are usually the paragons of governance too. I would like to mention some of the initiatives and tools that I have found effective to promote the performance culture. One is performance linked variable remuneration. Having a significant number of employees on a performance-linked variable remuneration system linked to appropriate metrics can make a significant difference in beneficially aligning incentives of employees and shareholders. At the Godrej group, we use EVA (Economic Value Added) as an across the- board metric, to provide a performance linked variable remuneration to our employees.
Also, one needs to have a strong performance management system in place. Top-performers should be rewarded disproportionately and laggards be put under the scanner. The best talent should be identified through a structured process and mentored carefully. Rewards and recognition can be used to spur both individual and team performance.
An increasing amount of evidence does suggest that there is a strong link between corporate governance and financial performance. It is also important to remember that ‘the market’ is the defi nitive compliance officer.
We know that the board of directors play a very critical role in ensuring sound corporate governance. How does it work for a family owned enterprise?
One of the most important dimensions of corporate seriously. The newly unleashed forces of deregulation, disintermediation, institutionalization, globalization, and tax reforms are making the minority shareholder more powerful, and are forcing the companies to adopt healthier governance practices.
How does one ensure sound corporate governance in a family owned enterprise?
Good corporate governance must include the framework of a strong performance orientation. Conformation to good governance is a hygiene factor – performance is important. Good governance needs to incorporate leadership and management imperatives that can lead to strong financial and strategic performance. Corporate governance and performance are not mutually exclusive – on the contrary, companies with sustained sterling performance are usually the paragons of governance too.
I would like to mention some of the initiatives and tools that I have found effective to promote the performance culture.
One is performance linked variable remuneration. Having a significant number of employees on a performance-linked variable remuneration system linked to appropriate metrics can make a significant governance is the board of directors. An alert and well-performing board inhibits conflicts of interest, ensures the presence of strong internal controls and a commitment to compliance; and confirms third-party verification.
A great board comprises great directors. And, the hallmark of a great director is courage. He or she must have the courage to protect the interests of the company, even if it means standing firm and opposing popular opinion, including those of the promoters of the company. The board should comprise professionals of distinction in their respective fields. The independent directors should be well compensated and be expected to spend quality time with the company. The board should inspire and ensure strong corporate governance, strategic posture and performance orientation in the company.
At the initiation of economic liberalization twenty-five years ago, the most frequently asked question in the first few years used to be “will the family owned, family managed business enterprises have a place in a competitive business environment, or will it fade away?” Our research has shown that family enterprises in India, particularly those belonging to family business groups, have done very well and consolidated their positions. Many of them have even emerged as significant global players. In your view what are the unique advantages of Indian family enterprises?
Family businesses in India (and elsewhere) have several inherent advantages, which provide them with unique strengths:
Trust lowers transaction costs: It is a well-documented fact that ‘trust’ lowers transaction costs, corruption, and bureaucracy. Trust can be a source of significant competitive advantage to a family business. In India, family businesses have often revolved around large joint families.
Small, nimble, and quick to react: Family businesses, both small and large, tend to be quick to react to threats as well as to opportunities. There are fewer decision-making gates and constituencies to deal with. Very often, the survival of the family depends on the survival of the business. This results in sharp and decisive action in the face of threats that could be potentially fatal for the business.
Information as a source of advantage: Many family businesses are private enterprises. This is an inherent source of an advantage since the private company can see the strengths and weaknesses of its public competitor and act accordingly while the converse is not true. Further, the private company can have private strategies, to which analysts and the competition are not privies. And, private family businesses have the freedom to pursue truly long-term strategies which are not constrained by ‘quarterly reporting.’
However, the continued success of family managed businesses is not guaranteed. I believe that an essential element for the long-term success of family managed businesses as with other forms of business will be a strong system of corporate governance.
Following several corporate scandals in the past one decade and the most recent unsavory episode in Tata Group, many commentators have opined that “while many family enterprises in India are professionally managed, they are often poorly governed”. While you also highlight the importance of corporate governance, what is your take on the adoption of corporate governance in family enterprises in India?
Over the last 20 years, there is much improvement in the way family businesses are managed in India. There is more adaptation of global ideas and training. This should continue. Institutions like ISB have played significant role in ensuring that more and more family enterprises take corporate governance seriously through training programmes, seminars and discussion forum for directors.
There are many companies, both private and listed, that have implemented a lot of governance improvements in their organizations. The market is also rewarding companies with good governance now, apart from performance.
I don’t think we should put too much emphasis on what happened with a few families or companies. Let us put it this way that there will always be some developments which are not good. And I think people will learn from those also. Overall I would say that over the last ten years Indian companies are better governed and Indian families are better managed. The trend is positive and I am glad. I believe that it will continue to improve.
Do you have any other observations and advice to further strengthen corporate governance practices in family enterprises, in India?
I believe succession planning is another important feature of a robust corporate governance system for a family enterprise. It is important to have a clear set of guiding principles that lays down the norms of stewardship for the family so as to preserve harmony within the family, manage expectations and plan succession through transparency and fairness.
In that case, what is your view on the process of grooming of the next generation family leaders in representing the family on the board? Should they be inducted into the board straight away or first soil their hands in managing the business before being elevated to the board position?
That depends on the requirements of each business, on the requirements of each family and the number of people in the family. You can have family members who are not involved in the management of the company and also on the board. Like you have independent directors, who are not involved in the management of the company. But they are briefed about what is going on in the company and their views are sought. The family council needs to decide on this matter.
Does the presence of non-family owners or their nominees create any special governance challenges for the family enterprises? By external owners, I mean either private equity funds or institutional owners who come through private placement route or listing in the stock market.
No, I don’t think it creates any special challenge for governance, but it creates a greater need for governance. Once you are listed there are certain additional requirements on governance which people have to follow. Therefore, we see improvement in corporate governance to a certain extent. So I think it is a good thing and wherever families have gone for listing or private equity funding their governance by and large have improved, which is a good trend.
Having said that, I also want to mention that I have seen some non-listed companies that are very well governed and some listed companies not so well governed. So listing might make governance a little better but that doesn’t mean that you need to list the companies for improving the governance. I reiterate that there are some excellent unlisted companies with excellent governance.
It is important to have a clear set of guiding principles that lays down the norms of stewardship for the family so as to preserve harmony within the family, manage expectations and plan succession through transparency and fairness.
Why do you think these firms adopt good governance practices and continue to be well governed even if they are not subjected to monitoring by the market or nonfamily owners?
It is a question of belief that governance is good, believe that if you have good governance the company’s performance will improve. So it is like asking why some people are ethical and others are not ethical. Also, there is now realisation that being ethical is rewarding.
When society was not so rewarding to ethical behavior earlier how was this belief inculcated in the Godrej family that good governance is very important irrespective of whether it is required by the law or not?
This belief has been in the family for many generations, automatically gets transmitted to subsequent generations and has been carried forward without anyone challenging the notion of good governance and ethics. It starts very early, from the time the children are being brought up. It is shaped through good training and setting good examples – that is how children learn. We are fortunate that it has been successful. Nobody from the successive generations has contradicted the belief in good governance and said that if we deviate a little here and a little there we will be better off.
Is there a link between family governance and corporate governance?
I think family businesses can do very well if they follow good family governance principles in place. At the same time a business would do very well to have principles of corporate governance in place. Family governance means the interaction between family members and the interaction of the family with the business. Corporate governance deals with principles by which the business is run and that promotes the interests of the business, which in turn promotes the future of the business. To my mind if both are done well then those family businesses will be very successful.
In a family enterprise how does a family decide who will be the chairperson of the corporate board and who will represent the family on the board as directors?
I believe in a simple principle that merit should take precedence. Sometimes it is good to have some experts from outside to help and guide. Sometimes it is best to discuss among family members and come to a conclusion. And then some rules must be laid down as to having some professionalism among family members working in the business.
What should be the relation between family council and the corporate board?
They are two separate entities having very different sets of objectives. The family council should manage the family’s relationship with the business and family’s relationship with each other. They should have their own schedules. The board has to manage the business and follow the corporate governance principles, rules, regulations and guidelines. The board must decide the future path for the business and family council has no role there.
You mentioned earlier that one of the sources of advantage for family enterprises is that most of the things are done on trust which reduces transaction cost significantly. But some family business leaders say that when you have external owners coming to the board the trust element is emphasised less and formalization is emphasised more. Business is conducted more in terms of the legalities, procedures, documentation, so on and so forth.
I think that is a mistake. There will be some more legal requirements in addition to the trust, when public or private equity infusion happens. But the trust part should continue. In fact even private equity, public shareholders and any external shareholder must respect private family businesses which are based on trust, enabling them to raise funds easier and at a lower cost. It is a question of some additional elements coming into play. It is like as society develops there are newer elements which come. That doesn’t mean that the new elements are contrary to the earlier elements. Just a little additional complexity gets added.
We have seen boards that are structurally very well crafted with renowned independent directors. But in terms of the process and functioning of the board it is not what you expect of them. As you have been chairing the boards for so many decades, what are some of the things you suggest that should be followed to improve the functioning of the board?
There are several things. One is the clear need to spend more time in board meetings. Also, I think it helps if the first board meeting is not too short. It should be properly planned and discussion must be in greater detail. Secondly, the board should be informed more about the company’s details so that they can discuss it well. Third, more time should be kept for meetings of independent directors by themselves. In other words independent directors meet, discuss issues, and then call the chairman and/or managing director to tell them what they feel, get feedback and discuss. That I think helps both the executive directors and it creates better output from the independent directors.
I think family businesses can do very well if they follow good family governance principles in place. At the same time a business would do very well to have principles of corporate governance in place.
As you are stressing on the role of the independent directors as a vital element of effective functioning of the board what profile of people should be considered as independent directors?
We should have independent directors who are knowledgeable on two fronts; professional- good legal knowledge, good accounting knowledge or good technical knowledge and industry or business expertise. Apart from the professional and industry knowledge, behavioural traits are also important. The executive directors must be open to feedback and they must make the independent directors feel that their inputs are welcome. Independent directors must have the strength to provide suggestions, inputs and also the strength to step down from the board when inputs that they truly believe in are not listened to or not accepted. When independent directors start stepping down from boards, and sometimes they do, then the working of the board will improve.
You said independent directors bring in different specializations. Similarly, should family directors also be assigned certain roles or does everybody play whatever role that they choose?
First of all, I strongly believe that family members who join a business should be very well professionally qualified. Otherwise they can remain a shareholder and not be active in the business. Even if they are on the board they should be professionally qualified. The qualification can be different. Somebody may be well qualified in law, somebody may be well qualified in accounts, somebody may be well qualified in management, and somebody can be well qualified in strategy. Hence the roles can vary. It can be a specialist role or a generalist role.
There are several things. One is the clear need to spend more time in board meetings. Also, I think it helps if the fi rst board meeting is not too short. It should be properly planned and discussion must be in greater detail.
Would you like to share some thoughts on the role of the chairperson?
Depending on the circumstances a company might have non-executive and the independent chairperson or executive chairperson or non-executive family chairperson. The chairperson, whether executive or independent, has to be very neutral and independent to be able to run the board well. Even if the chairperson of a board is a non-family professional, independence is the key. It is also important to have access to the family environment and be accepted and trusted by the family and also other stakeholders.
What is your view on the new law that all the boards have to have women representatives on the board? Post the enactment of this law we see that a large number of enterprises, barring certain exceptions like yours, have been fulfilling the requirement by inducting women family members, either wife or daughter or daughter-in-law.
I think it is a good law but I will qualify it later. Whosoever it is, men or women, must be professionally qualified. Having said that, I am against the way the law is worded. We shouldn’t discriminate against women just as we shouldn’t discriminate against men. So the better way to word it would be to say at least ‘x’ number of persons from each gender on a board. That is a better way to put it because it is non-discriminatory. For example, in some Scandinavian countries, the law says that we must have at least so many people from each gender.
There are certain communities that are historically against women family members’ participation in the business. It is a big challenge for them and they are resisting this. What is your view on that?
First of all, I am against such thinking and practices followed by some families. I don’t think it is right for people to discriminate against any gender. It is about time we change that. There has been discrimination even in inheritance, leave alone in participation. I am against such trends.
Finally, I would like to ask you about ‘enlightened ownership’. Can you talk about it in the context of sustainability of the family enterprises?
An example of enlightened ownership is emphasis on social impact. A company which emphasises on social impact and corporate social responsibility is respected by employees. Employee retention is better in such companies and there are lots of other benefits as well. Emphasising issues which are important for society and for the country always help a company. So I think, other things being equal, companies that emphasise such factors do better.
The owning families leaning towards such activities have a rub-off effect on the enterprises. There are certain things which are good for the company to do including social things, and there are certain things which the owners of the company should be doing. Both help.